Conflicted financial advice hurts IRA investors – MarketWatch

I have been preaching this for years: be mindful of mutual fund fees, index funds outperform 70% of actively managed funds, and there is no way to reliably identify the winning 30% in advance. Fortunately, for FIN101 students, you are taught what these “advisors” are doing and how to minimize exploitation. For those who haven’t had the pleasure of taking FIN101, take a look at my “Personal Finance Overview” presentation in the “Seminars” drop-down.

How do you believe Financial advisors should collect fees for the work they do? Class A shares, which I believe this article is talking about charge a large frontloaded fee of around 5 percent. Class C shares usually have no upfront fee but then in turn charge a yearly fee of anywhere from 0.5 – 1.75%. You could say that if they client stays in the fund for over 3 years than the class A fund is cheaper to them, but then you are not actively managing their portfolio. What would be your suggestion on how this could be fixed?

Perhaps a website like efficientminds.com on steroids could provide interactive portfolio construction tools that would put financial advisors out of business. Portfolios constructed from such an interactive platform would pick no-load, no transaction fee funds with expense ratios below even the 0.5% you quote (e.g., Vanguard Total Stock Market Index, VTSMX, with 0.17% annual expense ratio or the ETF equivalent VTI with a 0.05% annual expense ratio). But how would efficientminds.com make money showing everyone how they can get the same or better portfolio for less than half the cost? Another day…

Back to your question. First, we must define the work Financial Advisors do before we can talk about compensation. In general, it appears that Financial Advisors provide financial advice to those who are uninformed, don’t have the time to manage their own portfolio, or both. So, let’s be frank. Financial Advisors can charge more when their clients are uninformed. If you are aware you can open an account at Vanguard and get the same (or better quality) collection of index funds at 1/2, 1/3, perhaps even 1/10th the cost, then who needs a Financial Advisor? those who don’t know how to allocate their own portfolio.

How much should they be charged? Well, economically speaking, they should be charged a little less than it would cost them to get informed and do without a Financial Advisor. That varies from client to client and the availability of low-cost web-advisors.

if the client is uninformed and the Financial Advisor is managing the portfolio, then an annual wrap fee on the order of 0.25% or less with assets in mutual funds that are best for the client (read: index funds with the lowest possible fees). No high-fee mutual funds with kickbacks to the advisor or brokerage.

Telling someone “I’m not charging you” is a lie when in fact the Financial Advisor or brokerage firm receives some compensation for recommending an inferior and high-fee fund. Just charge the 0.25% (or less), eliminate kick-backs, and choose the lowest fee funds. That is my current understanding of the optimal.